Freeport Looking Bullish
Operating 13 mines in different regions of the world, Freeport draws around 50% of its revenue from copper. During the second quarter of 2013, the company achieved a cash cost of $1.85 per pound, a value significantly higher than last year’s $1.49. This increase was the result of the six weeks shutdown of operations in Indonesia, ordered by local authorities after an industrial accident claimed the lives of several workers. Despite this setback, Paulson & Co's expectations are positive, and it took on a large position in the company.
Freeport owns several copper mines, which in itself is already a huge benefit, since this base metal is one of the most difficult to discover. By conducting explorations near existing mines, the company is seeking to expand reserves and increase output to 5 million tons by 2017. Since the results of these explorations have been quite favourable, future additions to current reserves are concrete.
Furthermore, the company says copper production will grow around 25% over the next three years, due to investments made in the Brownfields project. Through expansion initiatives in South America and increasing production rates in North America, Freeport anticipates a copper production volume of 3.5 billion pounds by 2016. However, the downside to increased output is a higher cash cost per pound.
In addition to copper, the firm’s gold, molybdenum, gas and oil operations contribute to a healthy balance sheet. And, with the mining giant currently trading at 11.8 times its trailing earnings, it can be acquired at a significant price discount to the industry average. Considering China will grow slower, but on a larger base, and that Freeport has a solid financial position, I feel highly optimistic about the stock’s future.
Low Cash Costs Run the Game
Another large copper producer to keep an eye on is Southern Copper. Although it boasts a much smaller production rate than Freeport, the firm has 168 billion pounds of reserves, constituting the world’s largest copper deposits. Minority shareholders might be concerned because the Mexican conglomerate Grupo Mexico owns 81% of the company’s shares, and might take actions counter to their interests. Nevertheless, Ray Dalio of Bridgewater Associate recently bought a large stake in the firm that should fuel investors more confident.
Southern Copper has a cash cost of only $1.30 per pound of copper, one of the lowest in the industry and considerably lower than Freeport’s. The figure is achieved through low cost operations at 10 facilities in Mexico and three in Peru, which are a dependable source of free cash flow. However, labour unrest is a constant problem for the company. The strike at its Buenavista mine, for example, lowered operating income by $1.1 billion in 2008. Maintaining good labour relations will surely be one of the variables to dictate Southern Copper’s long-term results.
The other factor that will be crucial for the firm is the expansion of current operations. Volume can be increased by approximately 75% over the next five years if the expansions of Buenavista in Mexico and Toquepala in Peru, and Greenfield opportunities such as Tia Maria, are executed successfully.
With a large operating margin of 46.6% and very low cash costs, Southern Copper has an advantage over Freeport in both areas. Having more funds available to finance expansion projects, even in low copper price scenarios, will be highly beneficial for Southern Copper. Trading at 14.30 times its trailing earnings, stock is available a minor discount to the industry, growing my optimistic feeling about the stock.
Copper Is King in a Sluggish Commodities Market
With the commodities markets looking rather grim, large copper mining companies are an attractive investment option. Chinese growth, albeit the slowdown, remains a strong catalyst, as a steady level of demand is projected for the coming years. Although both Freeport and Southern Copper have good long-term outlooks, I would rather invest in the U.S. mining giant. Not only is its stock trading at a lower earnings multiple, but also because it is more transparent (as it does not rely on the interests of a large conglomerate with a dominant ownership position).
Disclosure: Patricio Kehoe holds no position in any of the mentioned stocks.